Thwarting Partnering Perils

Just like a marriage that's entered into with every good intention but ends with divorce, partnerships in the health club business often start out with good intentions but sometimes end poorly. However, a miserable end often results because precautions weren't taken — the number one precaution being agreements that deal with the operation of the club and contingencies for changes. These are better known as partnership or operational agreements and buy-sell agreements.

“I've opened about 200 facilities as a consultant with a number of different types of partnerships that end up going into war, and [the partners] were friends since grade school,” says Bruce Carter, owner of Optimal Fitness Systems International, a consulting company in Florida.

Lisa McGhee and Katherine Coltrin have been friends for more than 15 years. They've worked at many of the same clubs and even roomed together for a while. So, it only seemed natural that when the two of them talked about opening a personal training studio, they decided to do it together.

“We realized that we had the potential to develop the partnership together because of our strengths and weakness,” says McGhee. One's area of weakness is the other's area of strength. After three years of planning and talking to bankers, the two opened their club, Back Bay Fitness in Costa Mesa, CA, 13 months ago.

Even though the arrangement has worked out well for both, McGhee cautions friends who want to go into business together to think about it thoroughly before doing so because the friendship will change.

“Our friendship has completely changed,” says McGhee. “Our values and the people we want to be allow us to be deep friends, but we don't have the same social friendship that we used to have. It's like a marriage. The husband and wife are both exhausted people but they come home to the same place each day.”

McGhee urges people to create a partnership and a buy-sell agreement upfront even while doing the business plan. Carter agrees.

“No matter how well you get along with the person, protect yourself from any changes in the future in emotional states, which happens when money comes into play,” says Carter.

Whether you put together a partnership agreement or an operating agreement depends on whether the club is set up as a partnership (in which case you want a partnership agreement) or a limited liability company (in which case you want an operating agreement). In either case, the agreements do basically the same thing: They spell out who makes decisions, what has to be voted on, how the money is distributed and other operational issues.

Whichever way a business is set up, the owners also will want to put in place a buy-sell agreement. This agreement addresses each event that could happen to change the business: death, disability, bankruptcy, divorce and desire of one partner to sell his or her part of the business (which would call for a right of first refusal — allowing the other partner to buy the selling partner's piece of the business before it is offered to anyone else).

Club owners might also want to consider a repurchase agreement, which says that if one partner is no longer actively involved in the operation of the business, then the other partner gets the option to purchase the departing partner's part of the business.

The biggest mistake that club owners make is not setting up these agreements to begin with.

“The biggest mistake I see are the people who come in after they've been together a while,” says a California licensed attorney who preferred not to be named. “Either because they don't have one or they have a bad one and want to fix it. If you've had competent counsel in the beginning, it generally goes smoothly.”

To put together partnership and buy-sell agreements that work, consider the following:

Be reasonable and listen to others

Just going through the process of putting together partnership and buy-sell agreements can be stressful. Each partner needs to be sensible about expectations of himself or herself and the other partner(s). Each partner must also know what he or she wants and keep in mind not only what is best for himself or herself, but what is best for the business.

“We listened to other people who had done this and turned to a business lawyer who had done this before,” says McGhee. The duo also did their own research and agreed to protect the business upfront because they both wanted it to succeed. Because they were so in sync, McGhee and Coltrin easily agreed upon items in the agreements.

Determine input and percentage of ownership upfront

The percentage of ownership is key, says Carter. Partners must agree upon what each party is putting into the partnership (including money, effort, time and expertise) and how much ownership that entitles each partner.

“What often happens is you get it worked out and then one of them decides that they don't want to come in as often,” says Carter. “They don't want to put in the work they agreed to but they still want their percentage of the money.”

Therefore, the agreement should precisely spell out requirements and job descriptions.

“If they don't want to sign that, then you know you have a problem before you get into the agreement,” says Carter.

Consider everything

Death, disability, retirement, loss of interest, poor performance, success. Some of these outcomes are inevitable; some are only possibilities. However, when it comes to partnerships, even the slightest possibility must be dealt with beforehand.

Get insurance

Each partner should have a life insurance policy that names the other partner(s) as beneficiary, especially if the club has debt.

“It is a survival tool for the business,” McGhee says. “It will pay off the debt and the rest goes to the business.”

If one of the Back Bay partners dies, the other partner loses the revenue that partner brought in as a personal trainer at the studio plus the surviving partner must hire someone to replace them in their personal trainer role and their management role.

Consult an attorney

Ideally, each partner would bring his or her own attorney — experienced in business law — into the process to watch out for his or her interest and another attorney would represent the interests of the business itself. However, that often doesn't happen because it is too expensive, the California attorney says. Instead, club owners often hire one unbiased attorney that each partner can agree upon. That attorney will represent the interests of the business and will spell everything out for each partner without advising partners individually about what they should do. A partner who feels he or she needs advice from an attorney on any of the issues presented will have to hire an attorney on his or her own.

Club owners who can afford separate attorneys should ensure that their attorney is pragmatic, not argumentative, says Carter. Otherwise, the lawyer can end up arguing points for the sake of arguing and causing the partnership to end before it begins.

“Don't let lawyers ruin the deal,” Carter advises.

Be willing to pay

The cost to set up a partnership agreement depends on the size of the club and the number of partners. The larger the business and the more partners involved, the more it will cost. A club costing several million dollars could require $3,000 to $4,000 for an agreement. However, it generally runs between $500-$1,500, says Carter.

“The more money and assets, the more things are at risk,” says Carter. “Each partner wants to protect their own personal assets when they enter this.”

Be open to modifications

No matter how thorough you may think your agreement is, things change and you should be open to agreement modifications if they are necessary. In fact, an amendment clause should be included in the initial agreements to allow you to modify either agreement when agreed to by a predetermined number of the partners.

“It seems like it's a lot more than you want to consider, but in this legal climate we live in, you need to make a clear effort to spell things out,” says Carter.